Annuities are lesser-known but potentially impactful savings tools in your retirement planning toolkit, offering a steady income stream and some peace of mind if you’re concerned about possibly outliving your savings.
Annuities can be complex, however, so understanding their features, benefits, and possible drawbacks is important before deciding if they’re right for you.
What is an annuity?
An annuity is a contract between you and an insurance company that provides you with a series of payments at regular intervals. You can purchase an annuity as a lump-sum payment or in increments. In return, the company agrees to make periodic payments to you at agreed-upon intervals.
Annuities have two main phases:
- Accumulation phase. During this phase, you pay into the annuity as a lump sum or regular contributions, with the money accumulating tax deferred.
- Distribution phase. This phase begins when you start receiving payments. These distributions can be received for a set number of years or for the rest of your life, and they can even be structured to continue for your spouse’s lifetime.
Types of annuities
There are several kinds, but here’s an overview of the most common:
- Fixed annuities. These offer a guaranteed interest rate and fixed payout amount and are considered low-risk and attractive to more cautious investors.
- Variable annuities. Payments are based on the performance of underlying investments, such as stocks or bonds. They have the potential for higher returns but carry more risk.
- Indexed annuities. A hybrid of fixed and variable annuities. The returns are linked to a stock market index, providing the opportunity for higher returns while offering some protection against losses with a guaranteed minimum return.
Advantages
Annuities have several significant benefits, including:
- Guaranteed income. Annuities provide a steady cash flow, which can be especially valuable during retirement.
- Tax-deferred growth. The money in an annuity grows tax-deferred: You’ll only pay taxes on the earnings when you start receiving payments.
- Customizable payout options. You can choose to receive payments for a specific period, your lifetime, or the lifetime of both you and your spouse.
Disadvantages
Annuities do have some potential drawbacks, however, including:
- High fees. Annuities can carry various fees, including management, surrender and mortality, and expense risk charges, thus eating into your investment returns.
- Lack of liquidity. Accessing your money early can result in significant penalties and surrender charges, reducing the overall value of your investment.
- Complexity. Understanding the terms and conditions of annuities can be challenging.
Is an annuity right for you?
To determine whether an annuity is a good fit for your financial plan, you’ll need to consider various factors about your individual circumstances. If you’re looking for a guaranteed income stream in retirement, and are comfortable with the potential fees and restrictions, an annuity might be a good choice. However, if you need more flexibility and liquidity with your investments, or you’re concerned about fees, you might want to explore other options.
If you have questions about annuities or are looking for general investment advice, contact an LPL Advisor* with SELCO Investment & Retirement Services. They’ll be happy to help.
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* Securities and advisory services are offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. SELCO Community Credit Union and SELCO Investment & Retirement Services are not registered as a broker-dealer or investment advisor. Registered representatives of LPL offer products and services using SELCO Investment & Retirement Services, and may also be employees of SELCO Community Credit Union. These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, SELCO Community Credit Union and SELCO Investment & Retirement Services. Securities and insurance offered through LPL or its affiliates are:
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